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Corruption, taxation, and loan conditionality: a contribution to the macroeconomics of reform and transition with reference to Russia

By Dorothy Engmann


The primary objective of this thesis is to contribute to the debate on the reasons behind Russia's poor economic performance in its first decade after the fall of communism, by examining the role of IMF economic programs in the reform process.In particular, we are interested in the failure of neo-classical models of the market economy, upon which economic reform programs were based, to predict the outcomes in Russia. The purpose of the work is to offer a number of theoretical models which incorporate certain characteristics, such as political and economic motivations of both the IMF and Russian government, large-scale public sector corruption, a substantial underground economy, and a weak tax base, and which are capable predicting the resulting failings in the IMF-Russia economic reform program.\ud In chapter 2, we present a theory of conditionality in which the recipient, aware that the lender faces political and economic motivations in the conditional development lending process, undertakes a game with the lender in which the recipient attempts to undertake the least amount of compliance that guarantees it future loans. There is an exogenous conflict between economics and politics within the lending agency that determines its degree of tolerance for policy (non-) compliance. We then analyse how the donor, in an attempt to regulate its internal conflict, may adopt "rules of thumb" in the lending process which pre-define the actions it will take in response to the lender's level of compliance. The recipient's strategy depends on the payoffs it obtains from the actions available to the lender under each "rule of thumb". We examine how the IMF-Russia relationship from 1992-2002 has elements of the games we model.\ud In chapter 3, we model corruption a proportional tax on labour income in a three-sector economy with a corrupt bureaucracy, a legitimate private sector, and a shadow economy, and examine how tighter fiscal policies may result in a rise in corruption. The rise in corruption negatively affects legitimate private sector employment and output. We suggest that the Russian economy has a similar three sector structure and analyse the impact of reduced spending and increased taxation on corruption and employment.\ud In chapter 4, we modify Alesina and Tabellini's (1987) model of time inconsistency to allow for a weak tax base and then apply it to post-communist Russia. In particular we examine two non-consecutive time periods in which, for different reasons, public debt could not be used to finance the government's budget deficit: 1992-94 and post August 17 1998. We suggest that Russia did in fact move from one sub-optimal position to another, and we raise questions about the optimality of Russia's current monetary policies.\ud In chapter 5, we examine the optimality of monetary policy in the presence of bureaucratic corruption. We model corruption as a proportional tax on firm revenue and a positive function of the official tax rate. The higher the official tax, the higher the corruption tax levied by public bureaucrats in order to supplement their decreasing official net wage, and the lower is output. We find that under both discretion and commitment, inflation is higher, and output and taxation are lower, than when there is no corruption

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